A Diagnostic for Disruptive Innovation

You have three potential innovations, but resources to develop just one. Here are diagnostics to help you make the best decision. From Strategy & Innovation newsletter.

by Scott D. Anthony, Mark W. Johnson, and Matt Eyring

Would-be innovators know that one of their biggest challenges is systematically identifying the innovations with the greatest likelihood of creating disruptive growth. Pick the wrong one, and squander a year or more of focus and investment.

The good news is that it doesn't have to be the luck of the draw anymore. By conducting a series of diagnostics, companies in any industry can quickly identify the most promising opportunities. This article shows how to conduct customer, portfolio, and competitor diagnostics to pinpoint the highest-potential opportunities and the best business models for bringing them to market.

Though this article presents the three diagnostics linearly, they are rarely conducted in a linear fashion. Teams or individuals searching for disruptive opportunities can start with any of them. The results of one diagnostic will often cause an innovator to go back and revisit another. But the goal remains the same: Find the option that can set your company on the path to disruptive growth.

Customer diagnostic

This diagnostic assesses customers in order to identify "disruptable" market segments. Conducting this diagnostic involves looking for signs that specific customer groups either are overserved or are unsatisfied nonconsumers.

Overserved customers consume a product or service but don't need all its features or functionality. Three specific indicators point to this customer group:

People complaining about overly complex, expensive products and services.

Features that are not valued and therefore are not used.

Decreasing price premiums for innovations that historically created value. An overserved customer will say, "Sure, I will take the next version of your product, I just won't pay anything extra for it." For example, according to a January 2, 2004, article in the Wall Street Journal, large corporations are increasingly unwilling to pay for expensive upgrades to software programs. This indicates that software providers are overserving increasing swaths of the market.

Where should you look for overserved consumers? The most obvious place is your own customer base. If you find them there, you should immediately curtail investment in improvements in overserved dimensions because customers will not value them. More critically, you need to consider disrupting yourself because there is now room for a competitor to launch a disruptive attack.

The next place to look for overserved customers is in adjacent markets where competitors might be creating an opening for a disruptive assault by overserving their customers.

How should companies determine whether customers are indeed overserved? Interview them. Analyze margins and pricing trends. Read product reviews in industry journals. Quick-and-dirty market research can also help identify the dimensions along which customers are overserved.

The other group of customers to look for is nonconsumers, who generally fall into one of these categories:

Consumers who lack specialized skills or training, forcing them to turn to experts to solve important problems.

Consumers who lack adequate wealth to participate in a market.

Consumers who can use a product or service only in centralized and/or inconvenient settings.

Because nonconsumers lack the ability, wealth, or access to conveniently and easily accomplish an important job for themselves, they typically have to hire someone else to do the job for them or they have to cobble together a less-than-adequate solution.

Nonconsumers exist in every market. Indeed, the first place to look for nonconsumption is in an established market. Mapping a product's or service's delivery chain can identify opportunities where removing a link from the delivery chain will allow people to do for themselves what they previously had to rely on others to do for them. The health care industry teems with this kind of nonconsumption. Nonconsumption can also be unearthed by finding out what important jobs customers are seeking to get done that they can't adequately address with current solutions. Closely observing customers and conducting interviews and focus groups can identify these jobs.

One caveat: it's important to understand why people aren't consuming. Sometimes they just don't have a job they are seeking to get done. For example, many people can afford to purchase personal computers but choose not to because there are no jobs that are important enough to them for which the computer would be of assistance.

Portfolio diagnostic

The portfolio diagnostic assesses whether any current or potential innovations, such as new ideas or acquisition targets that produce appealing innovations, can be deployed in a way that successfully meets the needs of a disruptable customer group. This diagnostic involves looking at the technological characteristics of the innovation and at the potential business model by which the innovation might be brought to market.

Overserved customers consume a product or service but don't need all its features or functionality.

A low-end disruptive innovation meets the needs of overserved customers by providing them adequate functionality in return for lower prices. The technology of this sort of disruptive innovation offers "good enough" performance along traditional metrics and is supported by a business model that generates attractive financial returns at low prices. Discount airlines, discount retailers, and index mutual funds all created growth by offering overserved customers "good enough" functionality at lower prices.

New-market disruptive innovations connect with nonconsumers by making it easier for them to do important jobs themselves. The technology in this category has lower performance along traditional metrics but offers new benefits around convenience, customization, and simplicity that fit squarely with a customer's behavior patterns and priorities. The business model supports these new benefits by typically featuring lower prices and a different, usually simpler, distribution process.

The portfolio diagnostic should identify opportunities to shape innovations, because disruption is almost always a strategic choice. A company can modify a given innovation in ways that enhance its appeal to disruptable customer groups. It can choose the business model that best matches the characteristics of the innovation and the needs of the target customer group.

For example, one electronics company we worked with thought it had a new-market disruptive innovation on its hands. There were two problems with its assessment. First, the innovation offered benefits similar to the company's existing product but at a lower price. Second, the company planned to offer the innovation to its most demanding customers—customers who still were dissatisfied with the performance of the existing product they were purchasing.

This was a mismatch between the innovation and its deployment, but it did not mean the innovation should be scrapped. By performing a customer diagnostic, the company identified overserved customers in an adjacent market who were looking for "good enough" performance at lower prices. The company shaped the innovation into a low-end disruptive innovation targeted at these customers. This strategy provided a better match among the innovation, the target market, and the organization's abilities.

Competitor diagnostic

The third diagnostic assesses competitors to ensure that the selected opportunity takes unique advantage of their weaknesses and blind spots. First, it helps to evaluate whether a competitor will be motivated to respond. Second, it identifies whether that competitor has the ability to do so effectively.

As coauthors Clayton M. Christensen and Michael E. Raynor discuss in The Innovator's Solution: Creating and Sustaining Successful Growth, disruptive innovations typically take advantage of "asymmetries of motivation" by entering markets that incumbents are motivated to exit or ignore. Looking at a competitor's income statement, balance sheet, history of investment decisions, and customers can help identify the developments to which a company might not respond.

Companies tend not to go after opportunities in markets that are too small to meet their growth needs, for instance. They are often happy to shed their least-profitable customers in search of higher-margin opportunities up-market.

Companies that introduce disruptive innovations also tend to create asymmetric skills. In other words, they develop the unique ability to do what their competitors are unable to do.

How can you tell what a competitor might not be able to do? By evaluating its processes—the patterns of interaction, coordination, communication, and decision making employees use to transform resources into products and services of greater worth. A company's processes determine its skills and strengths as well as its limitations and weaknesses. Why? Processes designed to do one thing often get in the way when companies use them to do something they were not designed to do.

For example, a product development process designed to create complicated high-end products will not be good at creating simple low-end products. Similarly, a distribution process that involves close interaction with sophisticated customers will not be good at working with mass-market retailing channels.

The key then is to identify what processes a competitor has and what processes the company lacks. Processes are developed when companies solve the same problem over and over again. Airplane manufacturers Boeing and Airbus have to coordinate complicated networks of suppliers. Johnson & Johnson has to gain approval for new medical devices. Procter & Gamble has to develop effective product marketing plans. For these companies to be successful, they must have developed ways to repeatedly solve these problems. They need processes to facilitate this.

Determining the tough problems a company has solved to be successful can give insight into its processes, its resultant skills, and its potential weaknesses. The selected opportunity should then require building processes that potential competitors lack.

There is an important connection between asymmetric skills and asymmetric motivation. Asymmetric motivation gives a would-be disruptor time to hone asymmetric skills. How? Even though a competitor could develop the requisite skills to compete successfully during the early days of a disruptive market, it chooses not to. As the would-be disruptor grows, it sharpens its ability to do what the competitor cannot do. This hamstrings future competitive response because the disruptor has the advantage of accumulated learning and knowledge. In other words, asymmetric motivation acts as a shield companies can use to build asymmetric skills.

For example, one chemical company we worked with realized that finding a way to reach nonconsumers in developing countries was its ticket to disruptive growth. It had an in-process innovation that would allow it to dramatically lower the cost of the chemical it produced. Asymmetries of motivation would be on its side if it used the innovation to reach nonconsumers in developing countries; its competitors were not interested in pursuing what seemed to them to be a fringe opportunity. In addition, the chemical company would have to build unique skills to reach the new market, meaning it could race up the experience curve and lock in a sustainable advantage vis-à-vis its competitors. That approach could be the underpinning of a big new-growth business.

Putting it all together

By systematically conducting these diagnostics, any individual or team can quickly identify which opportunities within its purview are the most promising and therefore merit disproportionate attention. Sometimes, the one or two opportunities worth tackling are exceedingly clear. But other times, a number of seemingly equally promising ideas emerge. In these situations, create a weighting system where each opportunity can be rated against the factors discussed in this article.

Nonconsumers exist in every market.

When the highest-potential opportunity has been identified, build a preliminary business case for it. It should include a target customer, the characteristics of the selected innovation, the proposed business model to commercialize the innovation, and the predicted competitor response. In addition, the business case should highlight the key unknowns that need to be addressed while the selected opportunity is honed.

These diagnostics can also aid companies that are frustrated by their track record in making acquisitions. Many companies find that large acquisitions provide stable but lackluster returns, whereas small acquisitions typically have highly variable outcomes, occasionally producing blockbuster returns. Screening for small targets that match identified disruptive opportunities can, in essence, cut the tail off the returns distribution curve, allowing companies to capture disruptive growth before it becomes fully understood by the marketplace.

As an added bonus, this analysis will also highlight opportunities for sustaining innovations, the lifeblood of most companies as they allow existing companies to grow within markets where they have already gained a foothold. What kills companies is trying to introduce sustaining innovations into disruptive markets and vice versa.

Rigorously using these three diagnostics can help avoid this pitfall, allowing companies to systematically identify high-potential opportunities, address gaps between the planned deployment of the innovation and the factors that will determine its success, and begin to create new-growth businesses.

Reproduced with permission from "How to Place Your Best Bets," Strategy and Innovation, March-April 2004.